Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Wednesday, December 22, 2010

The Great Canadian Slump: Can it Happen in the U.S.?

The large decline in U.S. employment has had me reminiscing about Canada's similar experience in the early 1990s. I remember Pierre Fortin's presidential address to the Canadian Economic Association in 1996, entitled The Great Canadian Slump. Fortin seems to place much of the blame for this episode on the Bank of Canada; a claim hotly contested by Chuck Freedman and Tiff Maclem of the BoC here. I see that Stephen Gordon of WCI was reflecting on this episode in Canadian economic history as well; see here.

Let's begin by looking at employment-population (E/P) ratios. Population for Canada is 15+; for the U.S., it is 16+ civilian, noninstitutional (sample period 1976:1 - 2010:3).

The two series are similar up until about 1990. Then the recession hit. And it hit much harder and longer for Canada.

In 1990, E/P dropped by less than 2 percentage points in the U.S.; and dropped by about 4 percentage points in Canada. Now take a look at 2008; it is exactly the opposite. Canadians, apparently, don't need a world financial crisis to generate crisis-like employment slumps. In fact, the financial crisis appears to have had relatively little impact on Canada (that is, relative to the U.S., and relative to Canada in 1990).

One thing that might be of interest (or concern) for Americans is the length of Canada's employment slump. The E/P ratio essentially flat lined for about 5 or 6 years; and did not attain its pre-recession peak of 62% until well into the next decade.

Let me normalize real per capita GDP and the E/P ratio each to 100 in 1990:1. Here is what Canada's output and employment history looks like for the 1990s:

Now, that's what I call a jobless recovery!

It's interesting to look at other measures of labor market activity too. The next graph shows the participation rates (labor force divided by adult population):

Part rates are similar until 1990, and then exhibit almost a mirror image. Note that the U.S. participation rate shows some evidence of secular decline since reaching its peak. The next graph plots unemployment rates (unemployment divided by labor force):

The large gap in cross-country unemployment rates that emerged in the early 1980s and persisted for two decades elicited a fair amount of hand-wringing and a collective gnashing-of-teeth in Canada. To see what people were talking about, have a look here.

The main point I want to convey here for Americans is that the prospect of a prolonged jobless recovery, with persistently high unemployment rates, is not outside the realm of possibility. Such an episode has occurred in the recent past and, moreover, it occurred in an economy that is more similar to the U.S. than perhaps any other (in particular, Canada is not Japan).

This does not, of course, mean that a jobless recovery is inevitable. But I do think it might be worth exploring what parallels (if any) exist between these two episodes, and to see what might be learned from it. Will keep you posted, but in the meantime, feel free to share your thoughts.

Adam P: I do not know enough to even speculate on who or what was to blame. I plan to study the episode more carefully. (And I'll try to pick up Animal Spirits this Xmas). Would be interested to hear your opinion. Merry Christmas, btw!

One difference of Canadian experience seems to be that, unemployment rate did not rise too much, says 2% from 1989 to 1992, and actually DECLINED after 1992, though E/P remained in slump until 1996.

Part of it maybe due to the prolonged low participation rate in Canada. That took almost a decade. The low participation rate helped to reduce unemployment as less people in labor force. The prolonged low E/P seems to reflect so.

So why Canadian chose to leave labor force rather than searching for job in 1990s?

I don't really know anything about the Canadian economy of 90s either, basically just the chapter in Animal Spirits. So any opinion I give is really just an opinion on what Akerlof and Shiller say.

That said, I'm a big believer in the efficiency wage idea. This belief is largely based on my experience in the work force, when in grad school I didn't think it was plausible as a description of general wage setting behaviour.

Of course, I guess I'd count as pretty highly skilled so it may well be that my experience is not representative but efficiency wages are the only way I can account for my experience since I left school.

Thus, I sort of buy Akerlof and Shiller's argument. I basically tend to think that it's just a quirk of tradition in our labour market that reductions in the average real wage are accomplished through rises in nominal prices instead of by falls in nominal wages.

Some time in the 1990's there was a big change in US rules for welfare, IIRC. Was it under Bill Clinton's presidency? Does anybody remember exactly when?

What I'm thinking is that maybe the US experience in the 1990's is what was exceptional, rather than Canada's. US participation rates kept on climbing, despite the spike in unemployment, which normally discourages some potential workers, at least temporarily.

Second, check out the discussion section of that Steve Waldmann piece I gave you the link to earlier.

I'd be interested in your response to some of the issues discussed in that thread, especially those between Winterspeak and SRW. It is a little long but hopefully you'll have some time over the holidays.

I'd like to see you do a post on the general topic of savers, their expectations and what is required of the rest of the economy to have those expectations met. It seems to be a relevant discussion to have today.

Russ: The part rate behavior is interesting indeed. I doubt that it matters, but perhaps UI eligibility rules in Canada might contribute to this? (The rules do not necessarily require a person to be unemployed to collect UI).

Adam P: This seems related to Fortin's hypothesis. There may be some merit in this view. I wonder though, how much of the CAN-US employment gap it might account for?

Nick: Your basic theme emphasizing aspects of the U.S. economy (rather than the Canadian) is the one I took with Paul Storer and Paul Gomme in our CPP paper, though we focurssed on the 80s. In that decade, UI benefits became taxable in the U.S.; income tax rates generally fell; and there were administrative changes across states that effectively tightened UI eligibility. We estimate, however, that the combined effect of these changes could account for only a small part of observed differences.

Greg: Believe it or not, they actually expect me to do Fed work at the Fed. For my Christmas "holidays," I will be writing the annual report. But I will do my best to read through that Waldmann discussion. I never heard of the guy before, but the post you pointed out to me really impressed me.

Nick Rowe said: "Some time in the 1990's there was a big change in US rules for welfare... Does anybody remember exactly when? ...What I'm thinking is that maybe the US experience in the 1990's is what was exceptional, rather than Canada's..."

Forgive me, Nick; I don't mean to be rude here. But I cannot respect the analysis you offer: Pick a "cause" that suits your preconceptions, and then try to get people to find evidence for you? Really??

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